Stock bulls vs. bears: A 12-chart battleground

Stock pickers explain why the market can keep rising — or is ready to fall

Investors are at a familiar crossroads. Anyone who’s had money in the broad U.S. market is looking at 8% year-to-date gains. If they were smart or lucky enough to get in at the bottom four years ago, their portfolios likely doubled. And as an extra reminder of the good times, the Dow Jones Industrial Average
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has notched an all-time high. Now, some see more room to the upside while others believe we are in dangerous territory. Should you plow in, pull out or hold steady?

Usually, there are signs of pending collapse or further momentum that professional stock pickers use as guideposts. So we asked these stock gurus what metrics they’re looking at to make their investment calls. What makes them believe the new highs represent a floor for stocks? Or, what alarm bells keep them up at night? As you will see from the answers and charts that follow, strategists and traders are combing through a range of indicators, from comparative global GDP growth to corporate margins to the Federal Reserve’s balance sheet. As a bonus for those who make it to the end: A chance to make your investment call on where stocks are headed next. — Laura Mandaro

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First, let’s start with the worrywarts. As the Dow hit highs this week, the Chicago Board Options Exchange’s Volatility Index
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commonly known as the “fear gauge,” has stayed relatively low — currently at 13.5, below its long-term average of 20. Investors are more prone to buy stocks when volatility is high, typically after a selloff, because stocks are cheaper, said Todd Salamone, senior vice president of research at Schaeffer’s Investment Research. In contrast, when volatility is low, some traders view that as a sign the market may be nearing a top. Indeed, stocks began climbing after the VIX reached its 2012 peak last June. “The market momentum is going to slow,” he said. — Jonnelle Marte

Given the close relation between stock-market moves and quantitative easing measures, it’s hard to understand what all the fuss is about with the current rally, said Peter Schiff, president of Euro Pacific Capital. His favorite chart shows the S&P 500
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climbing in lockstep with Federal Reserve easing efforts, and falling in between the various programs. “It’s no great trick to create nominal price increases in real estate or in equities as the Fed is now doing,” Schiff said in emailed comments. “But these current gains come with a very steep long-term price. The U.S. is now committing itself to a strategy with no easy off-ramp. This can only end in a debt or currency crisis that makes the 2008 crash look like a walk in the park.” Schiff suggests being outside the U.S. dollar
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entirely, noting that Indonesian markets are up significantly more than the Dow since the past summer. — Wallace Witkowski

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When you contrast the S&P 500’s QE-fueled rise against the decline in median household income, what becomes obvious is a “Grand Disconnect” in the market, said economist Gary Shilling, president of A. Gary Shilling & Co. “As long as the Grand Disconnect exists you’ve got to be aboard, but you have to be aboard cautiously,” Shilling said. Market “shocks” could come in the form of a major European bank getting into trouble, a Middle East war-related oil spike, continued gridlock in Washington or the Federal Reserve shifting course on asset purchases. “In any event, I just think this is living on borrowed time and you have to have a shock strategy,” he said. Before the shock, Shilling suggests long stock exposure should be conservative, limited to dividend-rich stocks, and defensive sectors such as consumer staples. After the shock, however, Shilling suggests being long on Treasurys and the U.S. dollar, and short stocks and commodities. — Wallace Witkowski

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Doug Ramsey, chief investment officer of the Leuthold Group, said that stocks are deceptively expensive. Stocks are trading at 13 or 14 times next year’s earnings, according to most analysts’ estimates. But he thinks those earnings forecasts may be too rosy. The reason: Companies have spent years putting off hiring and buying new equipment, and boosted profit margins as a result. But as the economy continues to improve, that trend is not likely to continue. Add in rising interest rates, which will boost corporate interest expense, and Ramsey thinks a forward P/E of 20 is more appropriate. “We’re in the eighth inning of a cyclical bull market,” he said. — Ian Salisbury

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David Rosenberg, Gluskin Sheff + Associates’s chief economist and strategist, expects the market to correct soon — though not more than single digits. The bulls are just too powerful for anything worse, he said. Rosenberg doesn’t mince words about stocks. The Standard & Poor’s 500 Index would be closer to 1,000 if the Federal Reserve wasn’t catering this Wall Street party, he says. The U.S. market rally, on the cusp of its fifth year, has been “rooted far more in money printing” than any other catalyst in the past three decades, he notes, citing “negative real short-term interest rates and a tripling in the size of the Fed balance sheet.”

What could stop the bulls? Inflation, as usual. But the central bankers’ old nemesis is in hiding, and Rosenberg points out that the Fed appears more concerned about disinflation and the economy’s lengthy and fitful recovery. “Investors should hope we never get anywhere close to the 6.5% unemployment rate target,” Rosenberg said. “That would be terrific news for Main Street, but would mean the party on Wall Street would come to an end.” — Jonathan Burton

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Jeffrey Gundlach, chief executive officer and chief investment officer of DoubleLine Capital in Los Angeles, is bearish on U.S. stocks. He told Reuters on Monday that stocks are “obviously overbought” and that the recent rally has continued for too long. Gundlach added that he is “absolutely certain” that some of the stock rally has to do with the Federal Reserve. But he’s not bearish on the Japanese stock market. The chart shows how $1 invested in U.S. versus Japanese stocks would have changed in value since December 1989. Read more on Gundlach’s views and his recent webcast.— Saumya Vaishampayan

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Even many of the skeptics aren’t running for the exits. And those with a little more faith in the rally have plenty on their side. For a start, there’s the Fed. In a normal market environment, Barry Ritholtz, director of equity research at investment manager Fusion IQ, would point to reasonable valuations and strong corporate earnings as two key reasons to be bullish about stocks. That’s true of the U.S. market nowadays, Ritholtz said, but given the Fed’s “extraordinary” effort to support the U.S. economy, investing conditions are anything but normal.

“Between zero-interest-rate policies and [quantitative easing], the Fed is the driver of this bus,” Ritholtz wrote in an email. “Corporate borrowing expenses are very low, helping profits.” In addition, low interest rates are driving purchases of homes and autos.

Another reason to be bullish: Time heals all wounds — even an economy that was rushed to intensive care five years ago. The U.S. has experienced a painful recovery from the credit crisis, Ritholtz said, but there has been improvement as consumers deleverage and unemployment ticks lower. “It has been a slow process,” he said, “but it is moving in the right direction.” — Jonathan Burton

Bull markets end when the Fed takes away the proverbial punch bowl and short-term interest rates rise higher than long-term rates, according to Bernstein. The Fed has indicated that it does not intend to tighten credit availability anytime soon.

Bulls also are vulnerable when stocks are significantly overvalued and investors are certain that stocks are going up. Nowadays there’s still plenty of uncertainty and skepticism about U.S. stocks, Bernstein noted.

Similarly, bulls take a hit when stocks become the favored asset class. That’s hardly the case today, Bernstein said. “Many investors still do not even believe that a bull market is underway,” he wrote in a research note this week. “Investors continue to search for 5% yields and seemingly ignore the much higher total returns that stocks have been producing.” — Jonathan Burton

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Investors are taking profits and, in some cases, going short fixed income. Sluggish global growth prospects are limiting upside for most commodities, while gold is in the throes of a significant correction. Put that together with major central banks’ determination to keep liquidity flowing and you are “only left with equities to mess around with, aided by the fact that they are not still expensive,” said Ashok Shah, investment director at London & Capital, a London-based wealth advisory firm with $3.7 billion under management.

That said, it’s been nine months since the market saw a “decent correction,” Shah noted, in a telephone interview, leaving room for a near-term pullback. Beyond that, however, a strong case can be made for a gradual push further to the upside — a continued rally that’s likely to favor shares of “non-leveraged, cyclical” firms with “reasonably diversified” businesses, he said.

The ultimate driver for the market remains the liquidity efforts provided by the Federal Reserve, Bank of Japan and European Central Bank, aided by the likes of the Bank of England and Switzerland’s central bank, Shah said. Any sign that central banks are looking meaningfully to cut the flow could put the rally in danger. — William L. Watts

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Paul Theron, chief executive officer of Vestact, a South-Africa-based equities asset manager, said the economy plays a big part in his bullish call. “The most compelling reason to be bullish is that overall (global) economic indicators are trending upwards, and corporate earnings have been rising. U.S. employment is a specific number to track, and as you know, the inverse of weekly jobless claims correlates very strongly with the level of the S&P 500.” Many analysts have long looked to how weekly jobless claims mirror the U.S. stock market, which some say it has been doing since the beginning of the bull market in 2009. Theron said the correlation looks good even going back beyond 2009. Weekly jobless claims fell to 344,000 in the week ended Feb. 23, a level just above a five-year low. And the S&P 500 is inching ever closer to breaking through its record, set five years ago. — Barbara Kollmeyer

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“The market’s not cheap, but it’s not extraordinarily expensive” right now, said Harold Evensky, president of Evensky & Katz Wealth Management in Coral Gables, Fla. In other words, there’s still room for some growth. Measures of overall market valuation, the S&P 500 P/E ratio and the Shiller P/E ratio, are well below their past peaks. For example, the Shiller index is near 24 versus an all-time high of 44.2 in December 1999 (the Shiller’s median is 15.87). Evensky also thinks the Dow’s new peak itself may bring more money into the market, especially from skittish investors who have been sitting on the sidelines. “They should have been in a couple of years ago, but this is a wake-up call,” he said. Other positives: the Federal Reserve “remaining loose” on money. “I’m not sure that’s a long-term positive, but it’s a short-term” one for the market, said Evensky. There are risks too. Chief among them: Washington remaining in a perpetual state of partisan bickering, which “could torpedo the economy.” — Charles Passy

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The Barclays investment management arm started the year with a bullish forecast: a 14% return for large-company stocks. In a little over two months the S&P 500 has returned more than 8%. As a result, growth for the rest of year isn’t likely to match that torrid pace, according to Hans Olsen, head of Americas investment strategy. Budget battles in the U.S. or Europe could lead to a short-term pullback. That shouldn’t change the picture in the long run, however. One key reason: the market has yet to recognize the extent to which U.S. companies have boosted sales by pitching products ranging from iPads to airplanes to foreign buyers. By this metric, stocks are 13% cheaper than they were in late 2007, the last time the market set a new high. — Ian Salisbury

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